This week The Norris Group Real Estate Radio Show presents Bruce Norris segment of
I Survived Real Estate 2009. Bruce begins by discussing the declining housing inventory. A declining inventory typically means that the market is doing well, because you have multiple offers being placed on homes. We currently have the highest affordability rates in the history of California. The volume of sales has gone up to normal, but we have high unemployment.
Delinquencies have exploded. From July 08 to July 09, we have gone from 5.3 percent to 9.7 percent delinquencies. The inventory of REOs has gone down, because banks have not taken back as many as they should. Some people have not made payments in 14 months. Trustee sales have also declined during this same time period. We had 28,795 trustee sales in July 08 and then we progressed to the 9.7 percent delinquency rate. We are currently 306,000 trustee sales short of where we should be. That averages 25,000 homes going out per month in the future. We have not peaked at delinquencies, and according to reports, we will soon be at 13 percent delinquencies. At 13 percent, we will be releasing 70,000 homes per month. Bruce does not believe that we can have a positive market if these statistics are true.
FHA is going to have a large number of defaults next year. They once had a 203K loan for investors in which investors could buy a property and include the repair bill in the loan. A lot of people would use this kind of loan and they would buy up to 7 homes and use them as rentals. Bruce thinks this would help clear up a lot of inventory.
Bruce thinks that Fannie and Freddie programs should be expanded so that qualified buyers can get unlimited loans. We are currently stuck at 10, and many investors are capped out because they exchanged their homes out of California and moved their investments to another state. Those investors cannot sell their property and come back to California.
We are currently giving away homes for 8,000 dollars. That money is coming from tax payers. Bruce thinks that we should just let people take these homes for no down payment. We will have people walk away, but the next buyer will be able to easily take it. Under this kind of proposed program, it would not matter if the buyer qualified or not because this loan can be continually passed down. These houses could go to investors with a 5 percent interest rate. This program would not have foreclosure, because the problems would be solved by the next buyer. The people who have recently foreclosed on their homes will not be able to qualify for homes, which may keep them out of the market for the next few years. We could just reintroduce these people as buyers if they did not have to qualify. This is not a program that we have never seen before. We are trying to solve this problem by selling the next house to the owner occupant who was shoved into home buying by the nonsense financing of 05 and 06.
We are already doing zero down deals. When Bruce sells a property, he usually pays part of the closing cost. The person getting 3.5 percent down on a 100 grand purchase is getting an 8,000 dollar check; that is better than nothing down. If you just had nothing down and these people qualified, we would get rid of a lot of homes.
Bruce and many other investors believe that we need to get rid of the FHA 90 day flip rule. When an investor fixes a property, which may only take 3 to 4 weeks, and they sell it within 90 days, the investor is believed to be guilty of fraud. The lender has to pay the cost for this, because the investor will subtract the amount that he or she must pay the lender for the property. We need to start looking at investors as people who can help this problem. At some point, we must either choose to not foreclose, or we must pay catch-up in a painful market.
Bruce asks Christopher Thornberg if he expects the dollar to lose value, and how the value of the dollar impacts interest rates. As the trade deficit gets wider, the dollar goes up. Now the trade deficit is going to close, so the dollar will get weaker. There is very little doubt that the dollar will weaken. Interest rates are undoubtedly going to go up. The federal reserve has increased the money substantially and that money is going to cause inflation. The Federal Reserve is either going to let inflation happen, which will raise interest rates, or they will fight inflation by selling the long range securities they bought, which will also raise interest rates. One way or another, interest rates are going to go up. In the shorter run, it will be faster to allow inflation to occur, because that would bail out the asset markets. In 1982, the mortgage rate was 18 percent, because of the fear of inflation.
Bruce thinks that we can absorb a higher interest rate and still have a good real estate market, because the combination with the cheap price could absorb a double digit interest rate, just like in the 70s. Thornberg says that a 1 percent increase in the mortgage rate means a 10 percent decline in prices. Bruce disagrees with this, because between 1974 and 1980 we had a tripling in real estate prices and interest rates doubled. Thornberg tells Bruce that he is talking about the real mortgage rate, which is the mortgage rate minus the rate of inflation.
Bruce asks Thornberg what the statement Unemployment is a lagging indicator means. Thornberg says that means that the labor markets are the last to go into the toilet and the last to dry off. Bruce asks if that means when labor improves, every other category of real estate should have already started to improve. Thornberg says that residential real estate leads commercial. Now, we keep waiting to hear about the collapse in the commercial market, but we are not seeing this at all. Thornberg says that this sort of lead and lag mentality can be exaggerated.
This is why Bruce brought this up, because in the last cycle, employment improved in California from 1994-96 but we did not have a price increase until 1997. If we do not have price increases, builders will not build anything. Bruce asks if you can have an improved labor market if builders do not have any work to do. Thornberg says that these two factors do kind of work together. The prices started to go up after the labor increases from 1994-96. Thornberg reminds Bruce that in the early 90s we lost zero space, defense, and migration. In that market, the real estate was hampered by the excess supply. Thornberg takes issue with the idea that we should subsidize the building of new homes, because he believes that we have too many homes. Thornberg believes it would be a bad idea to subsidize the construction of homes when there is already too much inventory. Bruce says that some builders have been fixing existing inventory, and Thornberg believes that is all the builders can really do.
Robert Toll made 700 million dollars between 2000 and 2007 because he was selling too many houses at too high of a price, and now he wants tax payers to bail him out.
Bruce Norris asks Rick Sharga if people foreclosed for different reasons in 2008 versus 2009. Rick says that the reasons are not as different as the press would lead you to believe. The media has jumped ahead to the next wave of foreclosures. We are looking at a 3 wave foreclosure tsunami. The first wave began in the first quarter of 2006, because of the subprime meltdown and ARMs. The MBA numbers suggest that 33 percent of the new foreclosures are unemployment. That means that 2/3 of the foreclosure activity is not employment related.
What we are really seeing is increasing levels of foreclosure activity from the first wave, which is being made worse from the second wave. The second wave is about to pick up steam. If unemployment peaks around the first quarter of next year, we will see the foreclosures related to that peak around the 3rd or 4th quarter next year. That will be just in time for them to be augmented by the next wave. This next wave will be caused by the option ARMs. Many loans are going to reset, and people will owe more on their reset loans than their original loans.
Strategic defaults are going to be a problem. In the past American culture, people honored their contracts and chose to make their payments. Now people are realizing that the house they bought is worth half of what they owe, and they are wondering if it is in their familys best interest to keep paying. If someone is only 10 percent upside-down on a loan then they will probably stick with the loan, but if they are upside-down by 50 percent then they will probably default.
Thornberg asks people if their credit or their equity will hear quicker. Thornberg says that most of these people will have their credit heal faster. Sharga responded to Thornberg with a story about a Coldwell Bankerk agent that was fired. This agent counseled her customers to default on their current loan after qualifying and buying a second house. Bruce feels that there is still a lot of character being shown in California; a state with a 9.7 default rate that has had a 50 percent value drop.
There is a proposal being supported by 16 senators to increase the tax credit to $15,000 dollars for next year. The current $8,000 dollar tax credit started at $15,000 dollars, but it was then taken down to $7,500 dollars, and then it was increased to $8,000 dollars. MBA is supporting an open $15,000 dollar tax credit. That includes owner occupied and second homes. Every time someone buys a house, they spend an average of $7,500 dollars. That money goes into places like Home Depot, Lowes, Porter Paint, and furniture companies. MBA’s economist estimates that if the $15,000 dollar tax credit was approved today, then an additional 400,000 purchases would take place over the next year. $7,500 multiplied by 400,000 is a lot of money. David Kittle would argue that when these people begin to buy these homes that they would most likely be buying a foreclosure. The government is going to have to spend money to bail out that market anyway, so David thinks this is a better option.
Christopher Thornberg believes that this proposal is ridiculous, because you cannot expect the government to continuously subsidize everything. However, Christopher does think that there is a reason for governments to provide these opportunities, because the market can get into a death spiral. Temporary credit causes a short term burst in sales to stabilize the market, but then you must stop subsidizing and let the markets fix themselves.
One year ago, Fannie and Freddie were put into conservatorship. They were not too big too fail. If the government had allowed everything to fail, things would have been ten times worse than they are right now, but these problems would be over by now. We need to allow businesses to fail. Independent lenders are going out of business, because they cannot get warehouse line capacity. This is because the Obama administration has put on a capital requirement which forces these lenders to put a dollar into reserve for every dollar they lend. One year ago, we had 120 facilities that gave warehouse lines to lenders, but we now have only 12. As individual mortgage bankers go out of business, all the money is being funneled to Wells Fargo, Chase, BB&T, Bank of America, and Citi.
Bruce asks Joseph Magdziarz who has the final say as to what a property is worth. Is it the appraiser, the review appraiser, the underwriter, or is there a boss of the underwriter. The problem with government subsidies is that we cannot find the real market. When subsidies are affecting the market, we cannot find the true demand and supply balance. An appraiser usually has the opportunity to observe the property. An AVM is just an awful valuation model that may tell you which appraisal should be reviewed based on statistics. Joseph thinks that it is wrong for lenders to use AVMs to turn down an appraiser’s opinion. You should stay with you appraiser’s opinion, or you should get a review appraisal done. Unfortunately, that is not going to happen. We must remember that government intervention only postpones the eventual. We need to have a free market.
Joseph talked to five major builders in his market area. Most of them build 700 to 800 homes per year. One had taken 3 permits out this year, and he told Joseph that he never wants to own lots and subdivisions. He hired The Appraisal Institute to come up with a pricing mechanism, but he wanted a real value, because he did not believe that he could build his properties for what he could sell them. In most companies, the underwriter has the final say in the value of the property. Bruce asks if there is a boss of the underwriter who can trump the underwriter’s decision. The speaker claims that his company does not do this, but this may be true in other companies. One of the problems that Joseph has come across is that many of the underwriters are not certified, yet they are responsible for second guessing someone who is trained in appraisal.
Bruce asks what happened to the buyer’s ability to look at the market and say, “I’ve seen all the vacant houses that are listed for $75,000 and I want to buy this property at $135,000.” The system is trumping the buyer’s decision as if they have no idea what they are doing. Bruce provides an example of how this problem is affecting his company. Bruce bought a property in Moreno Valley for $50 grand and he fixed with $35 grand. When he attempted to sell the property, he got six offers within 48 hours for $120 grand to $122 grand. From Bruce’s perspective, that states market value. There were six buyers looking at all the market inventory and they thought Bruce’s property was a better deal than the other property’s priced at $120 grand, and they also thought his property was superior to the properties being sold at $75 grand. The appraisal for Bruce’s property came in at $102,000, and the review appraisal came in at $85,000. Bruce would not have been rewarded for his efforts if he sold the property at $85 grand, so he no longer makes the effort to buy and sell in Moreno Valley. The consequence for this is that there could have been a $120 grand comp for the entire neighborhood to enjoy, but now they have a $50 grand comp to look at, because they did not let the buyer determine what market value is. Bruce chose to keep this property and rent it for $1,150 dollars. The value of owning a house is being topped at half of rental value. Bruce thinks that is ridiculous.
Tommy tells Bruce that this problem would not have occurred if the property had been sold through an auction. Auctions are not contingent on financing. Most of the homes that Tommy sells are financing, but the buyer already knows what they are qualified for. In Tommy’s entire life, he has never had an appraiser dispute a house price that was sold in an auction.
Christopher Thornberg says the problem is that the banks worry about the appraisals, and they are not under the assumption that buyers are concerned about the appraisals. If we allowed a system where we had recourse mortgages again, then we would have deals in which buyers could buy houses above the appraisal value. However, the buyer would have to sign a deal which would allow banks to take the buyers assets if the buyer goes bankrupt. Bruce interrupts Thornberg, exclaiming that what Thornberg is proposing is that the appraisal system is correct. Bruce feels that we must respect the buyer’s decision more than that. Thornberg explains that the bank does not know that Bruce had six offers. They are under the assumption that there is only one accepted offer, and the appraisal came in at less than that offer. The bank is worried that if the buyer cannot pay his mortgage, which is half of rent, then they must turn around and they can only sell that property for $85 grand. If the buyer could sign a secondary note, making the deal a full recourse loan, then it shouldn’t make a difference.
Bruce asks John what the percentage of his sale price to his cost is in this market. The sticks and bricks costs about $50 dollars per square foot, but that does not include the land and the additional fees. In Fontana, John has built homes in the last 5 years that are now repos. John’s company tried to sell to people who were qualified and had good FICA scores. At that time, Wells Fargo was very nervous about the Alt A and subprime loan. John’s competitors would sell to anybody including investors and people who were not occupying the properties.
The federal first time homebuyer tax credit allows you to get the credit regardless of whether or not you paid any taxes. The state program only gives you as much credit as you have already paid in taxes. John must decrease his prices to encourage buyers to buy his homes. His homes are more expensive than foreclosures, so he must show the value difference between his homes and foreclosures.
John says that builders are not building 225,000 homes as Chris mentioned previously. Builders are currently only building about 40,000. John’s company will only build about 70 homes this year.For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.
